Basic knowledge not ideology is needed to fix the economy

Economics is a complex subject. However, the public’s lack of understanding of some of the most basic concepts, like supply and demand or microeconomics and macroeconomics, has led to a Congress that is being directed by ideology promoted by a few very wealthy people with special interests rather than by reason. Reports by Blinder and Zandi and Congressional Research Services and other data indicate that the Bush tax cuts on the wealthy are a big factor in the increase of the national debt and in the transfer of wealth from the middle class to the wealthy. Factions in Congress that are adamant about no tax increase are preventing reasonable discussions. A proposal is made that the engineering concept of feedback be introduced to the tax code that would tie a tax increase on the wealthy to any unemployment rate over 5%. The revenues would be directed to projects like infrastructure renewal that would increase employment directly and indirectly by increasing demand. The long term consequences of economic ignorance threatens the position of the US as a world leader.

The basics

It is not what people don’t know, but what they do know that ain’t so,

that causes the most trouble in this world – American folk wisdom

Whenever the people are well-informed, they can be trusted with their

own government – Thomas Jefferson

Over the past few months I’ve been doing an informal survey of what the average person I encountered knows about macroeconomics. Few even knew the difference between microeconomics and macroeconomics. For most people the basics of microeconomics are somewhat intuitive, i.e. take in more than you pay out and it works for households and businesses. Macroeconomics which applies to countries can be rather complex; the economist Von Mises said that no one one will ever fully understand it. It is a bit like the the story of the blind men and the elephant – every one who studies it comes out with a different idea. A basic problem is that economic theories assume that human economic behavior will follow a particular set of logical rules. Humans are not always logical or consistent so a plan of action might produce a particular result once and the different result another time. The introduction of new technology or a natural disaster can not be predicted. That does not mean that one should not bother trying to understand some of the basics like supply equals demand, and how they relate to our current situation. There is no magic wand or anti-depressant that can cure a sick economy. For an economy to get better, it takes technology, psychology, capital availability, and vision.

How did we get here

We did not get into the problem overnight, the seeds were sown over many years. Bill Clinton has admitted that one of his big mistakes was repeal of the Glass-Steagall act, an action that at the time virtually all Republicans and many Democrats endorsed. This opened the door to a number of questionable practices on Wall Street. Congress does not seem to have the ability to completely rectify the situation. Another legacy from the Clinton administration was the increased role of the government enabling home ownership. G. W. Bush compounded the problem by incompetently managing what turned out to be an unnecessary war financed by doubling our debt. The debt has continued to soar under Obama as a result of the Bush tax cuts, interest, the military spending that has been slow to wind down, and the slow recovery, all part of the legacy of Bush. According to the Congressional Budget Office (CBO) only 10% of the current increase is due to new policies of the Obama administration. There are many other factors involved, our economy does not operate in a vacuum, it is intimately tied to the rest of the world. When the LIBOR is fiddled, we get faddled.

Primary indicators of the state of the economy are the unemployment rate and growth of GDP. The current unemployment rate of 7.8 % is high by recent standards, raising the question of how it got this way and what can be done about it. One of the factors affecting this rate is the rate of saving. While there is a bit more complexity to the relationship, the higher the rate of savings the higher the unemployment. Think of it as people who are saving are not spending on goods and services in the marketplace. This does not mean that people should not save but there has to be a balance between saving and spending. Back in 2008 we had a negative rate of savings as homeowners thought that their home equity would serve as their savings and they piled up credit card debt. The problem was that historically home values track inflation, but home prices had grown above inflation adjusted values. This was largely due to the government policy of using Fannie Mae and Freddie Mac to make home ownership available to just about anyone, including many for whom ownership was not suitable. Although there were a few hints of “irrational exuberance” no public figure wanted to burst the Bush Bubble. When the bubble popped savings went from a negative to positive. In addition many banks switched from permissive to restrictive lending practices. Indeed, some businesses with good credit could not obtain loans to expand. There were other factors like lack of labor mobility because of high home ownership rates and problems in financial markets. In retrospect the low unemployment figures before the crash were an illusion masked by the effects of military expansion and the negative savings. The general consensus among economists is that it will probably take until 2016 to get to 6% unemployment with an estimate of 9 to 12 million new jobs no matter who gets elected and if there is no catastrophic event. Additional evidence that the problem is caused by limited demand is the large excess of job seekers and, except in the technology sector, wages that have been stagnant or falling. There have been some encouraging signs that the housing market is starting to stabilize in many markets and car sales are improving due to pent up demand.

Here are some comparisons from the Associated Press with previous recoveries after 3 years. Due to the housing glut, investment in housing is up only 8%, compared to the average of 34% in other recoveries. Ronald Reagan, the hero of those advocating lower taxes, increased government spending by 15% during his term and tripled the national debt from $900 billion to $2.8 trillion while he was in office. Federal, state and local government spending has declined by 4.5% in the last three years. In previous recoveries government spending over the same period increased by 12.5%. This is the first recovery in which government employment (federal, state and local) has decreased by 642,000 and which has eliminated a number of secondary jobs.

The stimulus packages

A number of people claim the emergency spending programs did not work, as the economy was not fixed. Actually there is good evidence that they halted the free fall and we could have eventually hit 16% unemployment according to these models from Blinder and Zandi or for this summary by Brett Spurr. The amount of the Obama stimulus was about half of what was recommended by some economists but was limited by Congress so we will never know if the additional stimulus would have sped up recovery. There are some inherent inefficiencies when applying a large stimulus and we may have reached a practical limit. There are just so many shovel ready projects available and stimulus money may have been spent on projects that were already funded. No doubt other models exist but the point is that claiming the actions of the government did nothing is ridiculous. Consider also the active steps the Republicans have taken to impede resolving the mortgage crisis by their support for the actions of Freddie Mac for not providing more assistance to homeowners. The Republicans have blocked employment stimulation initiatives. Analyzing the net benefit and cost is not easy and I suspect the claims made by either side are not correct. I have not been able to locate a truly unbiased analysis, but I think the proposal by the Democrats was a step in the right direction.

Macro and Micro

For individuals and businesses financial security and sustainable profit are the goals. Countries generally have multiple goals; security, prestige, well being of its citizens, etc. The reason for making the distinction here is that Romney is claiming that he has created jobs. A good part of that claim is that Staples grew from one store to a chain with 90,000 employees. From the standpoint of microeconomics he can claim creating jobs, but from the the standpoint of macroeconomics, employment in the office supply industry shrank 35%, ergo, it can be claimed that he actually destroyed jobs. In my home town there were three office supply stores that went out of business after Staples arrived. Venture capital companies can play an important role in creating new jobs by developing new technologies. Bain’s primary business is to restructure existing businesses to make them more efficient, frequently by elimination of jobs. The only publicly admitted investment in new technology that I have come across received extra attention from Romney and was a failure. An interesting example of a venture capital firm that has had an impact is the CIA funded In-Q-Tell. At least we have the hi-res screens on Apple iPads as a result of it.

What does all this mean?

Individuals, businesses, countries and civilizations fall because they fail to adapt to new technologies and circumstances. Some good examples can be found in “Collapse” by Jared Diamond. The demands that we return to the past or simply continue business as usual will not help. One of the factors in the fall of Athens to Sparta was the populous listening to soothsayers and demagogues instead of using reason.

One analogy is to consider the economy to be an airplane. The Bush policies put us into a death spiral and the Tea Party locked the controls. We need a captain and crew working together to get us flying straight and level through turbulent weather heading in the direction of lower greenhouse house gas emissions with peace, prosperity and better health for all. The captain should not be be directed by the passengers in first class looking out the windows on one side. This is not easy under the best of circumstances and is impossible in the current climate.

Pogo said “We have met our enemy and they is us.” Our ignorance is our enemy, and we may get the government we deserve as a result. Because of the flood of money from the super rich to influence the coming election we can go from a democracy to a plutocracy and judging from statements made by some candidates we can end up with an ilithiocracy (rule by the stupid). Perhaps the US should adopt a new motto: “ignari sunt victores” – the ignorant have won.